Capital Goods: February 2013

New take on tax reform

Bob Rucho calls his plan “fluid.” Actually, he doesn’t call it a plan. Rather, it is a “concept.” It is a concept that could change how everyone pays taxes in North Carolina. The Matthews Republican is co-chairman of the Senate Finance Committee and likely to be the key architect of any tax reform coming out of the General Assembly this year.

That he declines to call his ideas a plan isn’t surprising. Plans get shot down, and this one has a way to go even before becoming draft legislation. But Rucho has made it clear his goes beyond the previous notions of anyone who has ever had the political power to make this kind of thing happen. His concept involves doing away with the state personal- and corporate-income and business-franchise taxes. In their place, he would expand sales taxes to cover services, create a new license fee applied to all businesses and establish a 1% real-estate conveyance tax.

He doesn’t want to take just a bite out of the tax-reform apple. He wants to replace the apple with an orange. But does he stand a better chance than the Democrats did when they controlled all the levers of power in Raleigh? That depends on with whom you’re talking. Now that the Republicans are in charge of any rewriting of the tax code, conservative think tanks in Raleigh are loudly beating the drum for change. The North Carolina Chamber is chewing on the subject, calling tax policy “de facto economic development policy.” New Gov. Pat McCrory ruminated on it throughout his campaign, saying that the state needs a modern tax code that will create certainty and spur job growth. There’s a lot of wind in the sails of the tax-reform proponents. But it could turn into hot air for a number of reasons.

For one, the numbers may not work. North Carolina’s general operating budget requires about $20 billion. No one wants tax reform to result in an overall increase in taxes, but making the numbers “revenue neutral” means no substantial cuts in revenue. Eliminating the income and franchise taxes would drain more than $12 billion from the revenue stream. Even a recent study by the conservative Civitas Institute noted that a slight bump in the sales tax might be needed to produce the same amount of money.

Supporters of eliminating income taxes in favor of expanded sales taxes often point to Florida and Texas as models. North Carolina isn’t either of those places. The Tar Heel State isn’t bordered by water on three sides and teeming with free-spending tourists like the Sunshine State, nor does it gush oil revenue like the Lone Star State. Shifting more of the tax burden to goods and services will affect retail business, nowhere more than in McCrory’s and Rucho’s backyard, where Charlotte suburbs spill into South Carolina. If North Carolina’s sales taxes get out of whack with those of neighboring states, consumers living near its borders won’t hesitate to take their business across the state line.

And then there’s the pushback from businesses whose services are not now taxed. Whether mechanics, lawyers or even fishing guides, no one wants to add more costs onto what they sell. Democrats — with more modest proposals for expanding sales taxes to cover services while lowering sales-tax rates — could never get over that hump. They didn’t want to stir up a hornet’s nest of lawyers and accountants who would swarm into the Legislative Building.

Rucho’s more sweeping proposal is likely to stir up more stingers. As attractive as eliminating the personal-income tax may sound, that kind of change is going to create winners and losers. It is going to produce calls of regressive taxation. If the losers — shown by detailed analyses that will surely follow any plan put to paper — prove to be middle-class wage earners, the buzzing will get mighty loud.

Tax-reform proponents answer the criticism by saying that doing nothing isn’t an option. “The existing system isn’t going to work now or in the future,” Rucho says. Selling that idea, he points to the state’s worsening budget shortfalls. He notes that per capita income, compared with the national average, has declined since 1997. He produces figures showing stagnant job growth. It’s a good sales pitch, in the right quarters. It will need to be.